Financial Transactions Tax fails the test of reality... again

Financial Transactions Taxes (also known as Tobin taxes) are the fond friend of the banker-bashing left, believing that there are vast fortunes of money swirling around the ether that, if only they could take a tiny cut of it all, they could save the world.

It has been advocated widely by the likes of Paul Krugman, Bill Gates, Resource intensive fat capitalist dickhead hypocrite  Michael Moore, Greenpeace, Oxfam, WWF, Occupy Wall Street and Fidel Castro

So the EU proposed one, and it has been getting introduced in 11 EU Member States.

It appears to be failing to deliver ... and the Swedes would rightly say, having been there before, "told you so".

Cyprus bail out - the good, bad and the ugly

Cyprus has a stay of execution, I say that because its banks will never be the same again.  Indeed, if ever there was a case to allow full reserve banking (whereby loans = deposits, albeit with precious low returns if any), this is it.  Cypriots will want banks that exist purely to protect their money from being stolen, not banks that risk just that.  

Allister Heath has pointed out that there are some good dimensions to this deal, it is a lot better than how it was looking a week or so ago.  

The Good

- All deposits of 100,000 Euro or less are safe.  Given this was an ECB guarantee across the Eurozone, and the ECB has ensured this elsewhere, this was a minimum responsibility.  It may not be the wisest promise, but it was that. This will, at least, mean that most Cypriots have their savings protected, although plenty of businesses will get hit.

- As only two banks are in trouble (albeit two of the biggest ones), depositors for banks other than Laiki and the Bank of Cyprus, have their deposits untouched altogether.  Good.  It was a nonsense to effectively "nationalise" all bank deposits, including those of banks that are not having difficulty meeting their obligations.

- Shareholders of Laiki bank lose the lot, and bondholders get their bonds replaced by equity, as low as that will be. 

- Taxpayers are no longer solely responsible for bailing out the banks, but rather there is an orderly wind down of Laiki back, with depositor accounts transferred to an inheritor bank - the Bank of Cyprus.

In short, instead of a tax on all deposits, only depositors above the insured threshold of banks that need bailouts, get hit.  

The Bad

- Actual deposit insurance is not being triggered, rather there is just an exemption for those under 100,000 Euros (and larger cuts for those above it).  It saves taxpayers (as insurers), but it does disproportionately hit depositors when there is insurance that could be used to offset that.  Still, the state shouldn't be insurer anyway.  Allister Heath reckons it would have been better to wind down the banks completely, figure out a flat percentage of deposits across all accounts needed, and then used the insurance to recompense those under 100,000 Euros.  

-  There still isn't a legal place for basic "safe" banks to operate outside the fractional reserve banking system economically.  Many people would be happier, especially now, to have money sitting in a zero or near zero interest rate bank account that didn't face these risks.  These events ought to have accommodated that.

The Ugly

- Capital controls.  I said enough about that yesterday.  When removed, there will be grand capital flight.

- With what is about to happen, it will kill off Cyprus being a financial hub for a generation.  Just as well the country has good beaches and olives.  Maybe it will think again about rejecting the UN brokered deal to reunify the country with the Turkish occupied north.  That, along with Turkey being an obvious trading and investment partner (although the Greek Cypriot community may fear being overwhelmed), could help revitalise this country.   Many will lose jobs and find themselves floundering as a result, but they will pick themselves up.

- The rhetoric around "Russian money launderers" will haunt the EU and the ECB for many years.  It is one thing to have concerns and beliefs, another to air them without presenting evidence and without taking regulatory steps to address them.  To sweepingly act as if Russians with money in Cypriot bank accounts are all criminals is an unwarranted slur.  If there is substance in this, and the ECB cares, then there should be Eurozone wide directives to cover this.  

- Cypriot public debt will be at 100% of GDP by 2020 at best, given it is borrowing 10 billion Euro from the Eurozone to cover all of this.

- Cyprus has agreed to increase corporation tax to 12.5%, reducing its competitiveness.

Capital controls - the tool of the statist

"An economic and political disgrace" is how City AM editor, Allister Heath, describes it.

I call it theft.

Capital controls, a euphemism for banning you from taking more than a sliver of your property out of a particular country.

They are motivated by concerns over the "public good", over "the long term stability of the economy", when in fact the mere fact of introducing them speaks volumes about the latter, and is contrary to the former.

It is the logical end point of the moral turpitude of statists, whose fundamental belief is that private property, really, doesn't exist, but is tolerated and can be confiscated, controlled and shared as long as it fits the big picture, the grand plan.

The plans of politicians who think they know best how to run your life.

Cyprus has no future as a financial hub.  Confidence is utterly destroyed, as depositors, regardless of whether they individually will lose part of their savings as part of the bailout, will abandon its banks.

It's over.  Runs on banks happen because people panic about their property and their savings.  That money is their's, and they frequently worked hard and took time to make that money. 

They rightfully seek to protect it, withdrawing it from institutions that might take it from them, because money is an extension of the self.   It is the product of people's minds and labour, translated into a universal medium of exchange, and a means of storing that value.

Being able to take it out of a country is an extension of the right to leave, the right to take your life includes taking your possessions, includes your bank account.

Of course, banks are not foolproof.  In a free market, people rightfully take a risk in deposits with banks, particularly given virtually all banks engage in fractional reserve banking, lending much more than they take in deposits.  If a bank fails, then depositors should become unsecured creditors effectively being a segment of the new shareholders of the bank.

However, it is quite another thing for a sovereign state to do this, to restrict ALL capital flows out of a country.

You see the primary reason why a government does that is because it knows it has lost the confidence of its people, because it is about to steal from them in one way or another (in this case not through devaluation/QE of the kind propounded by Paul Krugman, Russel Norman and Robert Mugabe).  

It is a sign of failure, the tool of the statist and the act of a scoundrel.

Ed Miliband is an economic and moral vacuum

The UK Leader of the Opposition is empty.  His One Nation rhetoric is the antithesis of what he offers, which is a vision of "them" (the rich, which curiously excludes himself) and "us" (people on welfare, people working for government).

The man who offers envy, class hatred, regulation of private enterprise and more state housing to an economy lumbered by public debt that he denies is the fault of his very party when it was in power.

The man who uses terms of utter lies, like "bedroom tax" (there isn't one) and "tax cut for millionaires" (there isn't one, there isn't a tax on wealth), and fuels disdain and anger against entrepreneurs, private enterprise and success, by pandering to beneficiaries and state employees.

Read more here.

Cyprus in a nutshell

This is my go at summarising this.  Obviously, if someone spots something fundamentally wrong with my analysis, please leave a comment.  I don't profess to be an expert on the Cypriot financial sector.

Cyprus took a light regulatory touch to financial services, so its sector grew.

It gained a reputation for providing only the minimum level of scrutiny needed to comply with European banking rules, hence it tended to attract substantial deposits from Russians keen to keep their money away from Russian authorities.

Cypriot banks grew from this, but invested heavily in Greek public debt as a “safe” investment.

Greece approached bankruptcy, and the Eurozone (Germany) and Greece agreed on a bailout plan that meant its bond holder (those who lent money to the Greek government) would take approximately a 50% cut in their bonds.   This shared the burden between Greek taxpayers and Greece’s creditors.

Cypriot banks have been hit by this “haircut” in their investments, effectively being on the edge of folding without ongoing liquidity support.

The ECB is willing to provide some of this, but is demanding that investors in Cypriot banks take their share.  However, Cypriot banks issued few bonds, so simply demanding Cypriot bondholders take a cut wouldn’t be enough.  So the suggestion was made to take a cut from those who loaned money directly to Cypriot banks – in the form of depositors.

This runs contrary to the pan-Eurozone  guarantee for depositors up to 100,000 Euros.  

The reason given for wanting to confiscate Cypriot depositors is because “most of them are Russian” and “we don’t know where their money came from”.   Concerns that never translated into legal action, and which are at worst racist suspicions.

So now the Cypriot government faces its financial system collapsing.  It is happening now because the previous, communist led, government kept its head in the sand until the election it knew it would lose.

The Cypriot government itself does not have high public debt or a serious budget deficit.  It is not due to rampant overspending, but rather a banking sector that can’t cope with the bailout package for Greece demanding it write off substantial assets.

The Cypriot government is looking to the Russian government to save it, which from the ECB’s point of view means it wouldn’t be willing to provide ongoing liquidity, which means a real risk of a Euro exit, unless Russian support is substantial indeed (to the point where Russia would be the central banker for Cyprus, just think about that for a moment).

To get ECB support, it needs to find money from somewhere and could get it from a levy on deposits over 100,000 Euro.  

If no solution is obtained by Monday and the ECB stops providing liquidity, Cypriot banks will collapse and the Cypriot government may choose to print its own currency to cover spending, meaning a disorderly exit from the Euro by a country that – in itself – did not have a budget.  

Conclusion?

Cyprus’s financial sector is finished, regardless of what happens.   Local and foreign depositors wont trust its banks in most scenarios.

1. If Russia saves Cyprus, and it remains in the Euro, then it will likely mean a substantial withdrawal of deposits from Cypriot banks.  They will shrink, and Cyprus will have a bunch of effectively Russian owned banks operating within the Euro.  It is hard to see the ECB being willing to support this.

2. If Russia saves Cyprus, and it is forced to exit the Euro, then Cyprus will have a nearly worthless local fiat currency that does far more harm to depositors than a levy on Euro deposits.  It is over for Cyprus’s financial sector, but it will become remarkably cheap to holiday and buy land in Cyprus.

3. If the ECB saves Cyprus, along with Russia (providing the Cypriot share), then Cyprus will have a shrinking financial sector. Russians will be looking elsewhere to put their money.

4. If the ECB saves Cyprus, with a bank deposit levy, then Cyprus will see a massive run on its banks, and the financial sector will be effectively finished.  

5. If neither the ECB nor Russia bail out Cyprus, the banks will default, depositors may lose most of their money, it will be forced out of the Euro, and faces considerable civil unrest.

Who to blame?

- Greece, for being fiscally incontinent and being unable to pay back its debts.

- The Eurozone, for being unwilling to guarantee to Cypriot depositors what they guarantee to other Eurozone depositors, on grounds that it was never willing to address in the past.

- Cypriot banks, for being profligate lenders

- Cypriot depositors, for trusting the Eurozone and its government to ensure they avoid moral hazard.

-       Authors of the Euro, for not anticipating the inevitable credit bubbles a pan-economic fiat currency, driven by German economic performance, would fuel.

What to watch?

Monday.  The Cypriot Parliament and the ECB.

My bet is that Cypriots will be dealing entirely in cash in a week's time (they already increasingly are).

The Prodigal Greek has a great summary of the measures taken or soon to be taken, that will ensure this.